Margins in tech are horrible, but can earn you a premium

09/13/2016By Sammy Abdullah, CFA

If you’re a tech business, chances are your EBITDA margins are never going to impress anyone. I don’t say that to be rude, rather that’s just what the data says. We took a look at 76 tech companies in various sectors, from SaaS to Gaming, and the EBITDA margins across all sectors are anemic ranging from a median as low as -8% for SaaS to as high as 17% for Gaming. In spite of the very weak margins, revenue multiples are still very attractive, meaning investors don’t care that your margin is low so long as the business has offsetting attractive factors. The data is below.

TTM

TTM

TTM

Q2 2016

Q2 2016

TTM

TTM

TTM

Q2 2016

Q2 2016

Name

Ticker

Revenue

EBITDA

FCF

EBITDA/REV

Rev Multiple

Name

Ticker

Revenue

EBITDA

FCF

EBITDA/REV

Rev Multiple

Social

SaaS

Facebook

FB

$22,160

$11,080

$11,200

50%

15.02x

Qualys, Inc.

QLYS

$182

$43

$75

24%

4.93x

Line Corp

LN

$1,300

$159

$206

12%

7.59x

Fleetmatics Group PLC

FLTX

$311

$67

$99

22%

6.95x

Linkedin

LNKD

$3,430

$396

$1,000

12%

6.89x

Veeva Systems Inc.

VEEV

$439

$87

$148

20%

10.89x

Twitter

TWTR

$2,480

-$4,890

$578

-197%

4.70x

RealPage, Inc.

RP

$514

$68

$108

13%

4.06x

Medidata Solutions, Inc.

MDSO

$421

$52

$96

12%

7.24x

Median

$2,955

$277

$789

12%

7.24x

BroadSoft, Inc.

BSFT

$314

$38

$64

12%

3.77x

LogMeIN, Inc.

LOGM

$309

$37

$91

12%

6.19x

LinkedIn Corp.

LNKD

$3,430

$396

$1,000

12%

6.85x

Marketplaces

SPS Commerce, Inc.

SPSC

$176

$18

$21

10%

5.65x

Priceline

PCLN

$9,810

$3,710

$3,500

38%

7.57x

The Ultimate Software Group, Inc.

ULTI

$700

$66

$120

9%

8.66x

eBay

EBAY

$8,790

$3,070

$3,130

35%

4.04x

Athenahealth, Inc.

ATHN

$1,010

$85

$171

8%

5.11x

Match Group

MTCH

$1,120

$289

$229

26%

4.09x

salesforce.com, Inc.

CRM

$7,070

$522

$1,930

7%

7.75x

Sabre

SABR

$3,250

$739

$539

23%

3.29x

LivePerson Inc.

LPSN

$232

$16

$36

7%

1.58x

GrubHub

GRUB

$418

$94

$51

23%

7.03x

Lifelock

LOCK

$632

$35

-$38

5%

2.27x

TripAdvisor

TRIP

$1,470

$205

$440

14%

5.66x

IntraLinks Holdings, Inc.

IL

$285

$14

$35

5%

1.87x

Shutterstock

SSTK

$464

$61

$87

13%

3.97x

Cvent, Inc.

CVT

$211

$8

$46

4%

5.60x

IAC

IAC

$3,250

$381

$330

12%

1.54x

Atlassian Corporation

TEAM

$457

$9

$130

2%

12.07x

Expedia

EXPE

$7,740

$838

$1,430

11%

2.34x

RingCentral, Inc.

RNG

$339

-$9

$19

-3%

4.60x

Angie's List

ANGI

$340

$33

$18

10%

1.67x

Five9, Inc.

FIVN

$145

-$5

-$1

-4%

4.87x

Etsy

ETSY

$321

$30

$35

9%

4.16x

Jive Software, Inc.

JIVE

$202

-$14

-$10

-7%

1.02x

Zillow

Z

$741

$7

-$54

1%

8.08x

NetSuite Inc.

N

$846

-$59

$117

-7%

10.18x

Groupon

GRPN

$3,120

$7

$85

0%

0.83x

Shopify

SHOP

$282

-$21

$11

-7%

11.05x

Lending Club

LC

$508

$0

$52

0%

3.09x

Bazaarvoice, Inc.

BV

$200

-$15

$19

-8%

1.43x

Care.com

CRCM

$151

$0

$14

0%

1.59x

Marin Software, Inc.

MRIN

$108

-$8

$5

-8%

0.61x

ServiceNow, Inc.

NOW

$1,190

-$91

$98

-8%

10.14x

Median

$1,120

$94

$87

12%

3.97x

Appfolio, Inc.

APPF

$90

-$8

-$2

-9%

6.82x

2U

TWOU

$177

-$22

-$4

-12%

8.38x

Cornerstone OnDemand, Inc.

CSOD

$389

-$52

$48

-13%

6.26x

Content Distributors

Twilio

TWLO

$219

-$30

-$2

-14%

21.23x

Google

GOOGL

$81,760

$26,900

$28,980

33%

5.83x

WorkDay, Inc.

WDAY

$1,260

-$194

$328

-15%

11.75x

WebMD

WBMD

$671

$163

$151

24%

2.88x

Secureworks

SCWX

$362

-$57

-$18

-16%

2.81x

Netflix

NFLX

$7,620

$314

-$896

4%

5.43x

Benefitfocus, Inc.

BNFT

$212

-$36

-$35

-17%

5.82x

Yahoo!

YHOO

$4,890

$151

$1,050

3%

7.23x

HubSpot, Inc.

HUBS

$225

-$41

$11

-18%

8.47x

Yelp

YELP

$629

-$9

$60

-1%

4.02x

Wix.com Ltd.

WIX

$241

-$45

$27

-19%

6.03x

Pandora

P

$1,290

-$159

-$118

-12%

2.41x

Proofpoint, Inc.

PFPT

$313

-$60

$57

-19%

9.82x

TrueCar

TRUE

$264

-$34

-$1

-13%

3.12x

Mindbody, Inc

MB

$120

-$24

-$13

-20%

7.90x

Xactly

XTLY

$81

-$17

-$7

-21%

4.83x

Median

$1,290

$151

$60

3%

4.02x

Marketo, Inc.

MKTO

$241

-$51

-$4

-21%

6.14x

Zendesk, Inc.

ZEN

$261

-$78

$15

-30%

10.22x

New Relic, Inc.

NEWR

$202

-$61

$10

-30%

7.95x

Gaming

Splunk, Inc.

SPLK

$729

-$291

$163

-40%

10.03x

Activision Blizzard

ATVI

$5,370

$1,520

$1,640

28%

6.05x

MobileIron, Inc.

MOBL

$158

-$65

-$35

-41%

1.43x

Electronic Arts

EA

$4,460

$1,120

$1,050

25%

4.98x

Box, Inc.

BOX

$327

-$156

-$38

-48%

4.16x

Take-Two Interactive

TTWO

$1,450

$121

$109

8%

1.98x

Instructure

INST

$92

-$48

-$21

-52%

6.64x

Zynga

ZNGA

$750

-$20

$10

-3%

1.96x

Castlight Health, Inc.

CSLT

$82

-$77

-$58

-94%

3.01x

Hortonworks, Inc.

HDP

$155

-$219

-$98

-141%

2.99x

Median

$2,955

$621

$579

17%

3.48x

Median

$272

-$16

$20

-8%

6.16x

A few observations:

-Companies in Social Media, Marketplaces, and Content Distribution had median EBITDA margins of 12%, 12%, and 3% respectively. SaaS was even worse at -8% and Gaming was the best at a respectable 17%. In general, the margins for tech companies aren’t great because the cost of hiring developers and maintaining a tech stack is a burden that typical brick and mortar businesses don’t have to bear. Hence while gross profit margins may look great because there are no COGS, EBITDA margins suffer because the expenses of maintaining a tech stack and paying developer salaries weigh on the bottom line.

-In spite of the weak margins, the businesses above enjoy very nice revenue multiples. Valuations for Social Media, Marketplaces, and Content Distribution had a median revenue multiple of 7.24x, 3.97x, and 4.02x. Interestingly, Gaming which has the best margin at 17% has the worst revenue multiple at 3.48x (although that’s still respectable). SaaS, which has the worst margin at -8% has the 2nd highest multiple at 6.16x.

So does this mean you shouldn’t care about margins because investors are still paying high multiples for tech businesses in spite of weak margins? No, for a few reasons: i) many of the companies with the best margins enjoy extremely high multiples such as Facebook (15x with margin of 50%), Priceline (7.6x with margin of 38%), and Google (5.8x with margin of 33%). While the margin alone isn’t the driver of the multiple, it certainly is part of the equation; ii) public tech companies can get away with poor margins because they have fantastic growth characteristics. Indeed growth covers a lot of warts, but if you stop growing AND you have poor margins/cash flow, then you’re dead; and iii)generating a real margin means you’re generating real cash to fund the business which in turn means you don’t have to suffer as much dilution from fundraising.

In conclusion, tech margins are generally awful, so if you can be the stand out company with a great margin, not only will you earn a higher valuation but you’ll also have to raise less capital to grow.